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Recession Or No, People Have To Eat

January 13, 1991

Industry Outlook 1991: MANUFACTURING

RECESSION OR NO, PEOPLE HAVE TO EAT

After feasting for much of the 1980s, the $241 billion U. S. food- processing industry is eating humble pie. It scored 20%-plus profit gains in 1987 and 1988, thanks to falling tax rates, cheap raw materials, divestment of low-profit nonfood businesses, and the introduction of new products. But those numbers are relics of the past. Earnings should rise just 10% to 12% in 1991, an outlook that prompts this assessment from Sara Lee Corp. Chairman John H. Bryan: "The food industry is going to get more competitive."

Food processors will fare better than companies in many other industries this year. Consumers don't have to buy new cars in a recession, but they do have to eat. Still, they can steer clear of deluxe offerings. So "price increases certainly will be limited to inflation at best," predicts William D. Smithburg, chairman of Quaker Oats Co. In fact, rampant price specials, such as two-for-one offers and 50~-off coupons, will add to food processors' margin pressures and could set the stage for longer-term troubles. A. G. Edwards & Sons Inc.'s food analyst, John C. Bierbusse, says that shoppers will become accustomed to buying on discount. And over time, that will undercut the premium image of high-profit, brand-name products.

Nonetheless, food processors will probably try a menu of such strategies to spice up their results in 1991. And to afford to do so, some will have to resort to more plant closings and divestments. Unilever's Thomas J. Lipton Inc., for example, will close three plants and lay off 15% of its 5,800 workers to cut operating costs. Sara Lee will shut a sentimental favorite, its original bakery in Deerfield, Ill.

Buoyed by such efficiencies, the stocks of food companies could outperform the Standard & Poor's 500-stock index by at least 10%--and in some cases more than that. Companies with sterling growth, such as General Mills, Gerber Products, and CPC International, could sell at 14 or 15 times earnings this year, says Merrill Lynch & Co. analyst William F. Maguire. He says others will be lucky to trade at 9 or 10 times earnings: Borden Inc. has yet to show that the overhaul it began in late 1989 will improve its earnings. And H. J. Heinz Co. has been fueling profits more with cost-cutting than volume gains.

HOME COOKING. Investors like food stocks because a recession offers the industry a chance to grab dollars that once were used for eating out. Restaurant sales in 1990 accounted for 44~ of every dollar spent on food, up from 33~ in 1980, says John M. McMillin, an analyst for Prudential-Bache Securities Inc. If food processors can cook up enough new products, they may be able to keep diners at home more often, even after the recession ends.

Another potential for growth is sales outside the U. S., especially in the soon-to-be combined European market. Such companies as Kellogg, Quaker Oats, and Heinz have long had big markets and even production facilities there. Last year, Philip Morris Inc., parent of Kraft General Foods, spent $4.1 billion to buy Swiss candy powerhouse Jacobs Suchard. And longtime holdout General Mills Inc. joined Nestle to tackle the European cereal market, then snapped up Ranks Hovis McDougall's cereal business to gain a 15% share of the British market. Says General Mills Vice-Chairman Arthur R. Schulze: Because per-capita consumption of cereals is much lower than in the U. S., "we think there will be faster growth in Europe." Sara Lee, meantime, has just bought an interest in Hungary's third-largest food company, coffee-roaster Compack Trading & Packing Co.

Tapping into international markets is no picnic, however, mainly because the juiciest plums have been grabbed by Europe's food giants. France's BSN, for one, plans to build a state-of-the-art yogurt plant in eastern Germany this year. It also is making distribution deals with that country's dairy-product combines and is holding product-distribution talks with dairy companies in Hungary and Czechoslovakia.

Back home, meanwhile, many foodmakers intend to grab for a larger piece of the fast-growing fat-free market this year. They're impressed with how well Kraft General Foods did in 1990 with sales of no-fat salad dressings plus no-fat versions of Sealtest ice cream and Entenmann's baked goods, among other such items. Sales of these products may top $560 million in 1991, up from zero two years ago, Kraft executives say. Fat-free sales have cut into revenues from regular products, but Kraft doesn't mind: Its net volume gain from no-fat products is 50%.

TRUTH IN LABELING. As companies pursue the fat-free market, though, they'll probably make less aggressive health claims. The reason is new nutritional-labeling rules due soon from the Food & Drug Administration. Potato-chip companies, for example, may not be allowed to advertise that chips contain "no cholesterol," since chips never have contained cholesterol, just fat. Such changes "will help companies that make healthy foods and hurt those selling less healthy products," says Pru-Bache's McMillin.

The other big new-product push this year--in convenience foods--may face environmental problems. Even before McDonald's Corp. began dropping polystyrene cartons in November, Sara Lee's institutional food unit began putting cakes in cardboard boxes instead of polystyrene. And it took the cardboard out of bagel packages--saving $1 million a year. Even if replacement packaging costs more, however, foodmakers likely will switch. The environment "is an issue we're going to have with us for years," says Sara Lee's Bryan. In 1991, that's one more reason to expect slimmer profits from foodmakers.Lois Therrien in Chicago